Non Fungible Tokens (NFTs)

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Basics

"NFTs or non-fungible tokens are tokens with a unique property. If you consider popular projects that leverage NFTs: Crypto Punks or CryptoKitties, you will notice that each Crypto Punk and each CryptoKittie is its own unique entity. Just like fungible tokens, NFTs have their own standards, the most common being ERC-721 on Ethereum. However, as experimentation and adoption grow, new standards are developing and more blockchains are incorporating.

ERC-1155 may be the next most popular standard for NFT projects. Its main advantages are that it is a multi-token standard (projects can mint booth fungible and non-fungible tokens), smart contracts can be reused for multiple issuances, and it supports batch transfers."

"To understand what a non-fungible token is, we must understand what fungibility is:

In economics, fungibility is the property of a good or a commodity whose individual units are essentially interchangeable.

If a good, asset or token in this case, is fungible, then it can be interchanged or replaced by another identical token. Being non-fungible therefore means that a token is absolutely unique and is distinguishable from any other token.

The $USD is fungible in nature. $1 is exchangeable for $1. These individual dollars are essentially indistinguishable from one another. Fungibility is a core characteristic of all fiat currencies.

Non-fungible tokens are therefore completely unique expressions of an asset on a blockchain. In reading and learning about the Ethereum platform, you may have heard about Crypto Kitties. Collectibles are one early implementation of non-fungible tokens and the analogy of baseball cards is often used to describe how non-fungible collectables work. Many people are familiar with the idea of limited edition baseball cards. Non-fungible tokens work in the same way and are unique representations of an asset."

"Although not the first, NFTs shot to prominence in late 2017 with the rise of CryptoKitties, an Ethereum based game featuring thousands of digital kittens. Despite the seemingly simple premise it exemplifies many of the reasons why NFTs are exciting:

  • Uniqueness: Each CryptoKitty is unique, with NFTs able to be imbued with a distinct set of characteristics. In this case, it includes colour, facial expressions and fur
  • Digital scarcity: NFTs retain the scarcity associated with Bitcoin but amend it from 21 million (the maximum supply of Bitcoin) to as low as one. This scarcity (proved by the blockchain) means we can create both unique and irreplicable digital goods
  • Interoperable: Because they remain blockchain based tokens (ERC-721 tokens as opposed to the more usual ERC-20 tokens on Ethereum) owners can utilise NFTs in different ways e.g. ‘breeding’ two CryptoKitties to create offspring with new distinguishing factors
  • Platform: This interoperability provides the potential for third party services to build on top of NFTs. For example, CryptoKitties became the basis for other games such as HyperDragons - by ‘eating’ a kitten, players could increase their dragon’s strength
  • Composability: Whereas the ERC-721 standard allows for tokens with unique characteristics, the newer ERC-998 token proposal would see ERC-721 tokens able to hold accessories e.g. ball of string for your kitten.

This would also lend itself to branding opportunities, as companies could provide unique in-game items tied to their own services (e.g. just as luxury car manufacturers limit physical scarcity, so too could they create a limited number of digital cars).

These digital collectibles would also tie into other collectible markets such as trading cards, which remains a large market. For example, Major League Baseball recently announced its intention to create an Ethereum based game to capture a younger and digital first market for whom physical cards may feel slightly outdated.

NFTs can also remove the centralized services upon which gamers currently rely. For example, gamers must currently sell their items through either opaque over the counter deals or through fee taking centralized services. NFTs, however, could be transferred freely with selling items becoming as easy as sending a normal transaction.

What’s more, these items would become the property of their owner. At present items can be arbitrarily taken away from you; items are leased, not owned. With NFTs, however, the items cannot be taken from you. The whole world can see which accounts owns the NFT and full transaction history. This will give people more security and confidence when buying.

NFTs also offer the ability to create new gaming experiences. Items and avatars could be combined. Your avatar could become transferrable – along with all its earned accessories – from game to game. Instead of items being designed to be used within games, we may find situations where developers are designing games around items. Third party services will spring up to service and augment these new possibilities, and this will bring forth new ideas.

We already spend increasing amounts of time cultivating our digital profiles. Although games such as CryptoKitties may seem basic, they hint at a future where digital objects increasingly resemble the value of physical ones. NFTs will become another building block in the ‘Internet of Value’, where items that were once consumable and replicable become valuable owing to their scarcity. Bitcoin introduced scarcity to a decentralized digital currency, but NFTs may be the means to introduce the concept to a much wider audience."

How it Works

"In games and collectibles, the minting of NFTs is defined by the publisher or the development team. The team also defines the distribution of the items. These can be “claimed” as in the case of Crypto Punks, purchased at an auction, discovered in packs or crates, and so on. There is often an element of randomness involved."

"When we talk about NFTs, we’re usually talking about tokens created using Ethereum’s ERC721 token standard (although other blockchains have since adopted a similar standard). It was a way of creating smart contracts on the Ethereum blockchain for what are essentially deeds. Those deeds could represent physical property, such as houses or artwork, or they could represent virtual collectibles, such as digital trading cards or a video clip of an NBA highlight. Notice that the deed can be to something physical. Thus, the NFT (in most cases) is actually only the smart contract; the content and metadata are stored separately from the thing itself, mainly because it’s either too large or onerous to store on the Ethereum blockchain."

Usage

  • As of 11-2019 OpenSea is the de facto NFT marketplace with collectibles from over 180 unique dApps and even more one-off events (like SFBW attendance tickets).
  • From this tweet (6-10-2020):

"Daily trade volume for NFTs passed $1 million last week. @rariblecom is most popular, but seems like every week there's a new platform w/ non-trivial volume."

"Outside of Ethereum, WAX has been making progress utilizing the technology, as has Flow. A number of other ecosystems have also been experimenting with NFTs. The number of use cases for NFTs is growing and given the nascent state of the technology we are likely to see many more in the coming future. The key ones so far are art, collectibles and in-game items, virtual worlds, tokenized real-world items, permissions gateways.

NFTs are starting to integrate with other financial concepts. For instance, yInsure NFTs on Rarible enables users to buy and sell insurance for certain DeFi projects. The insurance is limited, but the concept shows how NFTs can be used to create a liquid market for such an asset.

There has been some experimentation with NFTs in the Aave ecosystem. The Aavegotchi may become an interesting implementation of NFTs in DeFi. These assets are simultaneously collectibles and revenue-bearing entities.

Furthermore, NFT tokens can theoretically carry rights to real-world sales revenue. For example, MetaFactory is implementing a concept where token holders maintain a right to a portion of the revenue from merchandise sales that use the image associated with the token."

"In recent months, the NFT space has expanded considerably, with trading volume across the top three NFT marketplaces reaching $342 million in February alone, up from $12 million in December 2020, according to DappRadar. However, despite the uptick in sales volume, NFTs remain a relatively small slice of the Ethereum pie. Although the number of ERC-721 contracts has surged to around 19,000, they're a "small fraction" of the 17.84 million smart contracts currently deployed on Ethereum, the researchers pointed out."

  • From Decrypt (6-7-2021):

"The first half of 2021 saw NFT sales volumes reach $2.5 billion, according to DappRadar. Since March, sales have totaled 10,000 to 20,000 NFTs per week."

NFTs can get lost

"The folks at CheckMyNFT, an NFT resource site, told Decrypt via direct message that there are several ways a purchased NFT could get lost or changed. For starters, the token with the smart contract might not link directly to the asset. Or the asset could be on a centralized provider such as Cloudinary, which NiftyGateway uses, that could eventually shut down. And the NFT could merely link to a URL, “which means that whatever is stored from that URL can be changed.

According to CheckMyNFT, storing the asset as an IPFS hash is better, because “at the very least the hash acts as an immutable fingerprint and with it you can verify the integrity of the metadata."

However, the file can still become “unavailable” if the asset is stored on IPFS and the only node storing it is disconnected from the network. “When you ‘upload’ to IPFS there is no guarantee that your data is replicated,” CheckMyNFT said. “Essentially what happens is that you tell other nodes that you are storing data at this address but that is it. Only if other nodes are interested in that data will there be replication.”

To make the most of IPFS, Filecoin’s Darrow recommends “pinning” data to IPFS. “It's taking that content hash and saying, ‘I'm going to keep storing this file, I'm going to make sure that it's available, anyone that can talk to me on the IPFS network will be able to get this file from me.” Several services do this for you, including Pinata and Infura. IPFS has really moved away from the permanent storage, 'permanent everything’ branding, because it’s just a very hard guarantee to make.”

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